Changing Tax Laws to Punish Businesses — Unless They Settle

The National Association of Manufacturers’ sent a letter to Senators on June 17 detailing the NAM’s objections to proposed language in H.R. 4213, the American Jobs and Closing Tax Loopholes Act, i.e., the tax extenders/tax increasers bill. One of many “pay for” tax increases in the substitute amendment the NAM disagrees with would tax punitive damages. As the letter from Dorothy Coleman, the NAM’s vice president for domestic economic policy, states:

NAM members also oppose the proposal to tax punitive damages in the bill. Under current law, a taxpayer can deduct damages that are a result of carrying on a trade or business, regardless of whether the damages are compensatory or punitive. The new provision runs counter to fundamental and well-established tax principles, and represents unsound public policy. By providing different tax treatment for compensatory and punitive damages, the proposal would depart from a central objective of federal tax policy – to provide similar tax treatment for similar behavior. Similarly, eliminating the deduction would impose a double tax on the same income since both the payor and the recipient would be subject to tax on the punitive damages.

Grover Norquist of Americans for Tax Reform also sent a letter expanding on the problems with the provision.

This latest version also contains a clear payoff to trial lawyers in the form of a brand new tax hike. In order to “pay for” a temporary extension of the first-time homebuyers credit, your substitute amendment would permanently deny employers the ability to deduct punitive damage assessments from lawsuits as a business expense.

This is bad tax policy for several reasons:
1. It is not tax reform. It is a permanent new tax increase to pay for a temporary extension of current tax relief. Over time, this strategy leads to a permanent net tax hike.
2. Businesses can deduct all “ordinary and necessary business expenses” under tax law. This has always included punitive damage costs. To deny this well-grounded deduction to employers is arbitrary and clearly intended to benefit a constituency.
3. Since settlements out of court are still deductible under this tax law change, trial lawyers will be empowered to file junk lawsuits (hoping that employers will choose to settle rather than risk a punitive damage award with no tax benefits). When a lawsuit is settled rather than challenged, the trial lawyer gets a guaranteed win.

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